The great ownership debate

The financial industry is falling foul of the Department of Trade and Industry’s BEE codes. This has resulted in a raging debate among members of the Financial Sector Council over the final ownership structure in the Financial Sector Charter.

Two weeks ago Finance Minister Trevor Manuel warned that pressure from labour and community groups on the Financial Sector Council would bring instability to the sector. But these groups, represented by the SACP and Cosatu, say 10% black ownership of the financial sector by 2017 would not be representative of the country.

According to the Broad-Based Black Economic Empowerment Act, all industries which had not had their charters ratified by section 9 of the Act by August 31 would have to comply with the department’s BEE codes.

Although progress has been made and most of the charter is aligned with the codes, the level of direct ownership differs.

Ownership itself is not necessarily more important than other aspects of the charter, but it is the one issue that industry and labour and community groups disagree on, and this has delayed the gazetting of the Financial Sector Charter as an industry code.

The charter requires black direct ownership of 10%, with the remaining 15% as indirect ownership. The codes provide for a different calculation of ownership and, depending on the structure of the shareholding of the financial institution, direct black ownership levels range between 13% and 15%.

The community and labour constituents of the Financial Sector Council would like to see the charter incorporate the department’s ownership codes. They argue that the codes are the universal minimum standards for broad-based economic empowerment and they will not be party to lowering the standards by accepting the current charter requirements. They add that in a country with a black majority it should be a bare minimum that black people directly own at least 15% of the financial sector, so allowing participation of citizens in their own economy.

The financial industry argues that further ownership is not necessary to meet the objectives of broad-based black economic empowerment and that changing ownership levels to meet the department’s requirements will have a negative effect on the industry.

Why they won’t
The financial industry has five key reasons for not aligning itself with the Department of Trade and Industry’s codes. The first is that when companies undertook BEE deals and went to existing shareholders to approve the dilution of their shareholding, it was understood that this transaction would be 10% of the shareholding. Investors like certainty and do not want to see the goalposts moved. This especially applies to foreign investors who do not understand the nature of South Africa’s transformation. Financial institutions are particularly vulnerable to sentiment, as was illustrated by last week’s financial turmoil in the United States.

The second argument is that under the Financial Sector Charter certain financial institutions, such as foreign banks and reinsurance companies, which do not conduct a significant portion of their business locally, are protected from the black ownership provisions. Under the department’s ownership requirements they would lose this protection and foreign direct investment in the country would be threatened.

Third, financial institutions argue that they have a far higher exposure to BEE deals than other industries. The industry is key in financing the hundreds of billions of rands’ worth of BEE transactions that will take place as a result of BEE ownership requirements. The industry argues that it cannot be compared with the IT industry, for example, whose only exposure would be through the ownership deal.

In many cases financing for BEE deals goes to institutions that have not built up capital or a credit history, increasing the risk. The industry argues that investors in financial shares have exposure to BEE deals both above and below the line, unlike other sectors. They add that the financing of BEE deals more than offsets the economic benefit of the additional black shareholding required of non-financial companies.

The fourth argument is a regulatory one. According to banking regulations, which incorporate Basel II requirements, banks have to maintain capital adequacy ratios. Further financing of BEE deals for their own balance sheets would affect their capital requirements. It would also remove funding for more productive empowerment investments.

In addition section 37 of the Banks Act stipulates that the Registrar of Banks must give permission for a shareholding in a bank above 15%. The registrar would be concerned if the black shareholder does not have the necessary balance sheet that can be applied in the event of a bank requiring more capital, as shareholders are lenders of first resort in the case of a crisis. For example, in 2001 Old Mutual had to provide a capital injection of R2-billion to Nedbank.

Finally, there are concerns about the dilution of value for existing black shareholders. There has been substantial capital growth in these institutions since the deals were concluded and any unravelling of such deals would be to the detriment of black shareholders and the economy.

Why they should
The community and labour constituents, represented by the SACP and Cosatu, believe that many of these issues are smokescreens to protect the financial industry from real transformation. They say the ferocity of the arguments varies between financial institutions: those with narrow black ownership will be affected the most, while other institutions have a more broad-based ownership scheme and are closer to the Trade and Industry Department’s codes.

As for concerns about foreign shareholders and other investors not wanting to see the ownership goalposts moved, they argue that this is the industry’s own doing. The industry knew at the time of concluding the BEE deals that they would still be subject to the generic codes and should have conveyed this to investors. The national treasury assured investors at the time that the Financial Sector Charter ownership levels would be maintained, but the community argues that this was done under false pretences and shareholders were misinformed by treasury and the banks.

With regard to the protection of non-South African institutions, the community and labour groups are comfortable that an equity equivalence agreement can exist within the terms of the Financial Sector Charter. They say under the charter this protection applies only to banks and they would see this extended to cover any multinational.

The group questions the proviso that BEE deals inherently carry more risk. To date the financial industry has financed R56-billion worth of BEE transactions, above the charter target of R50-billion. The group argues that if these deals were not financially viable banks would have stopped at the target rate. It believes the exposure is profitable and good business for banks.

The regulatory issues have not been formally tabled to the Financial Sector Council for discussion, but labour and community groups argue that it is assumed by the banks that all further deals will be vendor financed. There are wealthy groups in South Africa—the Royal Bafokeng, for example that would not require vendor financing. The Public Investment Corporation would be able to finance BEE deals and black entities could seek foreign financing.

With regard to regulatory approval above the 15% ownership level, the Trade and Industry Department requirements are a maximum of 15%, so this should not be an issue. The regulations assume there would be one shareholder. Community groups would like to see further ownership deals done in a more broad-based way. Higher ownership levels do not seem to be a problem for Nedbank and Investec, both of which have significantly higher black ownership than the 15% required by the department.

Community groups and labour have little sympathy for the argument of the wealth for existing black shareholders would be destroyed, saying that broad-based empowerment is not meant to protect narrow-based shareholders. The effect on shareholders and banks varies, depending on the nature of the deals, with Standard Bank and Absa possibly more negatively affected.

Ultimately, community groups and labour believe that the department’s codes give a better account of ownership over time than the charter does.

Where to from here
The Financial Sector Charter has been submitted to the Trade and Industry Department to be gazetted under section 9 of the Broad-Based Black Economic Empowerment Act. This will change the charter from a voluntary to a mandatory one, with which all financial companies will need to comply.

According to the Act, a period of 60 days must be allowed for public comment before a charter can be gazetted. This period will expire on October 31.

The draft document has not yet been approved by community groups and labour. If the Financial Sector Council cannot reach an agreement, a political decision will have to be made by treasury and the Department of Trade and Industry.